T-Mobile: The Most Successful Merger in Telecom History
A look at how T-Mobile used a merger to jump from last-to-first in the 5G era. Also my thoughts on wireless market. I have recently purchased some T-Mobile shares.
I’ve flirted with the wireless market over the last year or so (I own some AT&T on a situation and value play – ~6x EV/Ebitda, simplified business, and paying down debt with steady cash flow), but I’ve been working under the assumption that wireless carriers are bad businesses. It’s not hard to see why; they deal with aggressive competition (has kept ARPU growth close to non-existent), require significant capital investment (spectrum and nationwide networks), and are forced to discount handsets to incentivize customer sign-ups. Add on people love to hate their wireless carrier and you have a pretty tough business…
Before we get to T-Mobile (TMUS 0.00%↑), a quick detour to talk about the hate for wireless and broadband providers. Maybe I’m crazy, but I think wireless and broadband connections are great value at ~$2-3 a day. Our lives rely and run on these connections, and our world pretty much ends if they stop working. I’m not opposed to cheaper prices (I’ll happily call to try lower my bill), but my connectivity spend is probably the best value per dollar in my monthly budget. You get access to the internet pretty much anywhere in the U.S. for ~$50 a month, not far off the price of a haircut!
Anyway, back to the T-Mobile (this post isn’t sponsored by big wireless I promise). Despite some of the inherent industry characteristics, I think T-Mobile generates solid returns over the next few years. But let’s start with how they used a merger and the rollout of 5G to go from last-to-first in network quality.
1. The Merger
We all know the legacy T-Mobile, the customer friendly un-carrier with low-cost plans, in your face commercials, and the unmissable magenta color scheme. Historically seen as a second-tier player in the wireless market (behind giants AT&T and Verizon), they managed to pull off “the most successful merger in telecom history” and become the leading 5G network. They did this through a perfectly timed and well executed merger, along with some assistance (missteps) from competitors.
A deal involving T-Mobile had been on the cards for a while; in 2011, AT&T agreed to purchase T-Mobile for ~$40bln, but after significant regulatory scrutiny AT&T backed out and paid ~$4bln in breakup fees. In 2014, Sprint, led by Softbank, looked at acquiring T-Mobile for ~$20bln but abandoned the bid after regulators, again, said they’d oppose the deal; the FCC Chairman at the time, Tom Wheeler, had publicly stated a desire to keep 4 national wireless carriers.
In 2017, T-Mobile began sizing up a deal to acquire Sprint (a reversal of 2014), thinking the Trump administration would be more receptive. The talks ended after the two sides couldn’t agree on terms, but restarted a year later and a $26bln stock deal was announced in April 2018. The deal got support from the FCC this time, with Chairman Ajit Pai making the following statement:
“Sprint has lots of mid-band spectrum, but the company standing alone does not have the capacity to deploy 5G in this spectrum throughout large parts of rural America.”
14 state Attorneys General filed to block the merger but, in February 2020, the judge sided with T-Mobile, agreeing with the FCC that Sprint:
“Does not have a sustainable long-term competitive strategy to remain a viable competitor.”
The deal closed in April 2020, with certain conditions for T-Mobile:
Within 3 years cover 97% of the U.S. population and 85% of rural Americans with 5G service.
Within 6 years cover 99% of the U.S. population and 90% of rural Americans with 5G service.
Divest ~9.3m Boost Mobile subscribers (sold to DISH for ~$1.5bln).
Provide an option for DISH to buy 13.5MHz of spectrum in 800MHz band for ~$3.6bln (this option expired in June 2023, but an extension was agreed through April 2024).
Provide DISH with a 7-year wholesale agreement, allowing them to sell T-Mobile wireless service under the DISH brands (MVNO agreement).
The hope was the merger would allow T-Mobile to accelerate their deployment of 5G and compete with Verizon and AT&T, while at the same time DISH would step in and become the 4th national wireless carrier (replacing Sprint). T-Mobile certainly accelerated their 5G deployment, but the emergence of DISH as a viable 4th national carrier has yet to materialize…
2. Merger Benefits
The merger created a number of benefits for T-Mobile, but the biggest was getting Sprint’s 2.5GHz spectrum (~150MHz). I’m going to keep this high level, but some background on why spectrum is so important to wireless carriers will help frame T-Mobile’s rise to 5G industry leader.
Spectrum
Wireless communication uses airwaves to transmit bits of data. Carriers must use different frequencies to transmit their data, so they don’t interfere with each other – think radio stations using different FM channels. The FCC decides what frequency is used for what purpose, and auctions off spectrum bands to the likes of T-Mobile and Verizon for wireless connectivity. Different bands have different characteristics:
Low-band is frequencies <1GHz. Low-band covers large areas but offers slower speeds (range usually 1-3 miles but can be >10 miles in certain circumstances). Speeds are usually <100mbps.
Mid-band is 1-6GHz. This is now known as the “goldilocks” band for 5G as it offers good speed with a reasonable coverage range. Quality is dependent on how close you are to a tower but can be similar to lower tier cable broadband (~100-300mbps downstream in good areas).
High-band (mmWave/millimeter wave) is 24-52GHz. Offers the highest speeds (can be >1gbps) but is limited in range and penetration; signals can’t travel more than a few thousand feet and struggle to penetrate glass and trees.
The amount of spectrum you have is also important. The more spectrum (MHz) a wireless carrier has, the more traffic they can facilitate on their network. Similar to a highway, the more spectrum, the more lanes available to transmit data.
Sprint was using their mid-band (2.5GHz) spectrum at the time of the merger, but hadn’t got far with the build out. This meant T-Mobile could quickly transition the spectrum to their own network and begin rolling out their mid-band 5G service (called “5G Ultra-Capacity” by management).
The Layer Cake
T-Mobile’s 5G “layer cake” strategy was not the consensus view when it was unveiled in 2018. Neville Ray (T-Mobile’s network chief at the time) laid out a vision where 5G would be run using the three spectrum layers (low, mid, and mmWave): low-band would be used for broad nationwide coverage, mid-band used in metro areas to provide high speeds with reasonable range, and then mmWave in certain dense urban areas.
5G was initially expected to be run on mmWave, providing incredible speeds for IoT type applications (driverless cars, metaverse, virtual reality etc.); Verizon used phrases like “wireless fiber” when describing their 5G plans back in 2016. T-Mobile thought differently; they focused on low and mid-band, with more targeted mmWave spectrum for coverage in places like sports stadiums and concert venues.
They were proven correct when, in 2021, Verizon and AT&T spent ~$80bln on ~225MHz of mid-band spectrum (C-band operates in 3.7-4GHz mid-band range). Ookla estimated that <1% of mobile traffic utilized a 5G mmWave connection at the time. Remember, T-Mobile spent $26bln for Sprint, which included ~150MHz of 2.5GHz spectrum and ~30mm customers!
This wasn’t the end of the good news for T-Mobile. Verizon and AT&T then had to wait for the C-band to be cleared by prior users (satellite operators); they were able to build out infrastructure and had access to a small portion of the spectrum band (upgrading towers, radios, etc.), but only got full access in July 2023, over 2 years after T-Mobile got unrestricted access to 2.5GHz band.
Summary
A well-executed merger, a smart bet on underappreciated mid-band, and competitor missteps meant T-Mobile was able to get a two-year head start in the 5G era. This turned them from a low-quality value provider to a leader in network quality.
3. 2021 Analyst Day
In early 2021, T-Mobile held an investor day to give detail on their 5-year vision for the merged company. The day focused on four areas that would drive to T-Mobile’s success through 2026:
The 5G race
Growth opportunities
Merger synergies
Financial projections
5G Race
As mentioned above, T-Mobile got a significant head start in 5G from the merger, but a key question was could they hold onto the advantage? Management pointed to higher quality spectrum assets, even after the C-band auction. The 2.5GHz band covers ~50% more land mass per tower than the C-band VZ 0.00%↑ and T 0.00%↑ purchased (3.7-4GHz). They estimated the C-band spectrum requires ~1.5x the number of sites compared to T-Mobile’s 2.5GHz (T-Mobile had ~85k macro sites vs ~70k for competitors in 2021). Additionally, Verizon and AT&T would only get access to all their C-band allocation towards the end of 2023, while T-Mobile plans to have their 5G build “substantially complete” by then.
Bottom line, competitors spent ~$80bln to correct their original 5G mistakes, took on a lot of debt to do so (this spend was effectively maintenance capex!), and now need to spend more capital deploying their spectrum and building out cell sites.
Growth
The first area management pointed to for growth was rural. T-Mobile has historically lagged in rural markets due to coverage issues (network quality) and less distribution scale (retail presence). Management estimated rural America is ~50mm households and ~130mm people. Their share in 2021 was ~13% (compared to their overall market share of ~30%), and with their newfound network advantage, they believe they can increase share to ~20% by 2026. To do this, management planned to increase retail store counts, market their 5G advantage, and rollout Metro by T-Mobile (prepaid service) products for more price sensitive customers (prepaid service).
Next was business growth. Similar to rural, T-Mobile has historically under indexed in the enterprise market (~$27bln in 2021 and expected to grow to ~$40bln by 2025) but had grown significantly over the last decade (had relationship with ~75% of the S&P 500 and ~10% market share in 2021). Their goal was to leverage their 5G advantage (businesses value network quality more than consumers) and double their share to ~20% by 2026. They planned to do this by increasing ad spend, and investing in their sales team.
They also planned to begin offering FWA (fixed wireless home broadband), making use of excess capacity in certain geographies. This was the first real incremental monetization of a 5G network from a wireless carrier (5G had just meant faster speeds until FWA). While focused on rural areas, where there’s less competition and where T-Mobile would have more excess capacity, management emphasized this is an option in suburban and urban areas as well (pick off dissatisfied legacy cable customers). Management estimated they would have ~7-8mm customers by 2025, or ~$4bln of high margin revenue (no last mile infrastructure required like cable and fiber).
Synergies
Management increased their expected synergies from ~$6bln, at the time of the merger, to ~$7.5bln at the investor day; ~$5.5bln would come from a reduction in costs to serve or avoided, mainly from ~35k decommissioned macro sites and a rationalized retail presence. Additionally, $2bln would be saved from combined SG&A (headcount reductions etc.).
Financial projections
Management finished by laying out their financial targets for 2023 and 2026 (see slide below), as well as teasing a potential $60bln buyback program.
Given we’re now in 2023, we have the benefit of comparing their operating and financial guidance to current year estimates:
5G race – On pace to cover 300mm POPs with mid-band by end of 2023, competitors are aiming for ~200-250mm. Management does not expect competition to catch up any time soon as their 2.5GHz band requires less tower upgrades due to a larger coverage range. Upgrading from 200-300mm POPs requires 3x the tower upgrades compared to 100-200mm.
Growth – Rural and business remain on track per management comments (rural at ~16.5% share and enterprise had highest gross add month ever in Q2 2023). FWA has been a home run with ~4.2mm customers as of Q3 2023. Management is still guiding to ~7-8mm fwa subscribers in 2026.
Synergies – Continue to hit on their targets and have even increased the expected full run rate synergies to ~$8bln. Merger-related costs are now pretty small and will continue to wind down.
Financials – We’re not at the end of 2023, but estimates have them exceeding all targets from their investor day. They’ve also initiated a buyback to begin returning excess capital to shareholders (as well as a small dividend they hope to grow ~10% a year).
So, over the last 5 years, T-Mobile managed to execute on “the most successful merger in telecom history” and go from a distant third in network quality to the number one. The stock has doubled over the last 5 years but is only up ~12% since the investor day (peers have performed worse - Verizon is down ~40%, not including dividends, on macro and industry concerns).
Let’s move onto the wireless market and current outlook.
4. Current Wireless Market
The postpaid wireless market has been in growth mode over the past few years, driven by a few tailwinds. First, there was covid, increasing the need for connectivity and expanding the population that needed a smartphone; kids were getting phones younger (parents wanting to keep them occupied) and grandparents were getting smartphones to FaceTime family members. Second has been the migration of prepaid to postpaid contracts; this was driven by increased credit scores, and cable converting historical prepaid customers to postpaid. Lastly, a continued increase in business lines as more workers utilize two phones (business & personal). This led to postpaid phone adds of ~9mm in 2022, way above the pre-covid average of ~5-6mm.
The market is concerned adds will trend back towards historical levels (2023 estimates are for ~7mm adds in current year) and cable will continue to take a significant share of those adds. This leaves the three national wireless carriers fighting over ~4mm adds, rather than the 8mm they’ve been used to over the last couple of years. David Barden, BoA analyst, had a quote that summed up current market sentiment (this quote didn’t represent David’s opinion, just what he thought market sentiment was):
“Telco carriers are kind of watching the water evaporate in the desert, someone is going to be forced to do something irrational to survive.”
The concern is valid. Wireless carriers have shifted back to offering free phones in exchange for multi-year commitments over the last few years, all in an attempt to lock-in customers to pricier data plans. Discounting has grown in popularity as device costs have increased over the past decade, making customers more open to giving up flexibility for a discounted/free device. All three carriers currently offer up to $1k off new iPhones if you sign up for a 24–36-month contract (Verizon & AT&T are 36, T-Mobile is 24).
I think the market is missing how much the merger has changed the industry; we haven’t really had “normal” operating conditions since 2020 (when the merger closed). T-Mobile and Sprint were seen as scrappy low-cost offerings with coverage limitations but lower pricing. Now we have 3 similar sized players with cable operating as a 4th low-cost provider (I’d include DISH as a potential risk, not a viable competitor). The charts below show postpaid phone share and connections in 2019 vs 2023.
The industry is in a better place now, with 3 large players and a small-scale 4th (cable), that doesn’t have access to owners’ economics. ARPU has been the key issue for the wireless industry, there’s been pretty much no growth over the last decade, despite massive 5G investment and exploding data consumption. Now we have 3 players of similar size and similar network quality (once 5G buildouts are complete). No one needs to take share to survive. T-Mobile even tried a classic AT&T & Verizon play, forcing users on legacy plans to move over to new offerings (which just happen to more expensive…). They backed off once the news leaked and customers voiced their displeasure, but the “un-carrier” appears to be slowly adapting to their new standing in the industry. Not a great sign for customer wallets but a good sign for industry profits, even if this specific effort failed.
Cable is the new 4th player, but there are some key differences. Usually, you’d expect a 4th competitor to aggressively undercut the competition on price to get enough scale and share to survive. Cable definitely competes on price, but their motivations are different compared to a classic small-scale player. Cable is not primarily in the market to make a significant profit, they’re offering wireless because they think it improves the churn profile of their precious broadband customers (defensive move). They’re also limited as they run as an MVNO on Verizon’s network (don’t have owners’ economics - they do have a better deal than other MVNO’s though due to a 2011 deal with Verizon), forcing them to focus on more price sensitive customers who are willing to monitor data use. I’m still positive on cable wireless offerings (even though I recently sold my Charter position), but from the perspective of lowering broadband churn and increasing overall customer value (not as a profitable standalone wireless competitor). If cable feels their broadband situation is stable, I’d expect them to be comfortable with a lower share.
Summary
Wireless adds will slow from covid highs, and cable will take a large share for the foreseeable future, but I think the concern around massive promotional activity decimating profits is overstated (the industry will still grow). AT&T and Verizon are focused on paying down debt after spending heavily on mid-band, and T-Mobile is starting to act like a member of the telco giant club (price increases, dividends etc.). I actually think we could see some moderate ARPU growth over the next few years.
5. Risks
The biggest risk for wireless carriers is phone connection growth slows and competition ramps up as carriers fight for a smaller add pool, but I’ve covered that above, so I’m going to focus on some of the other key risks for T-Mobile.
Valuation – you can get AT&T and Verizon for ~15% free cash flow yield (~6x EV/Ebitda), vs ~9% (~9x EV/Ebitda) for T-Mobile. T-Mobile deserves a premium multiple; they’re growing off a small base in rural and enterprise and they’re the leader in fixed wireless. The risk is share growth normalizes over the medium-term, benefiting the slower growers. This links nicely back to the quote from David Barden; the carriers with the smallest share of gross adds are willing to discount the most to get it back. Verizon has consistently said the first thing they’re focused on is getting back to consumer postpaid phone growth; but they’re also focused on paying down debt from their 2021 spectrum investment. I think we see cautious competition with T-Mobile continuing to take an above average share, and all players looking to moderately increase ARPU (T-Mobile will have to come up with something more creative than their plan migration attempt).
Network – the network quality advantage T-Mobile currently has will continue to shrink. T-Mobile points to the additional work to get from 100-200mm POPs and then from 200-300mm (~3x the towers), but while this might be true, the quality gap still closes as you get more coverage (even though the work gap doesn’t close, the POPs gap does). I don’t see this having a major impact, but probably leads to a slight share shift to Verizon and AT&T as they catch up (on a POP basis).
Cyber security – there have been multiple cybersecurity issues that T-Mobile has struggled to get on top of. They’ve had 5 breaches in 5 years, with the 2021 breach compromising 77mm people’s data and resulting in a $500mm fine. It’s hard to quantify the cyber issues, but it hurts the brand and fixing the underlying IT environment isn’t an easy task (change culture, system upgrades etc. take time). They’re taking it seriously but have a long way to go.
Capital allocation – There’s rumors T-Mobile is looking at fiber broadband (they have some active pilots using a wholesale model), or maybe even acquiring another telco like FYBR 0.00%↑ (they denied this specific rumor during the Q3 cc). It’s not that I’m against T-Mobile acquiring a fiber focused telco, it’s more just a reminder/warning that allocating excess capital is a completely different game than putting capital back into your business with an obvious best use (e.g., integrating a merger and building out a 5G network!). I’m not saying management will be bad at allocating excess capital (I like the buyback program), but it will be very new for the organization and a significant change from how they’ve historically operated. I’ll be watching this closely.
Margins – Not really a risk, but useful info; T-Mobile gets asked this question a lot as their Ebitda margins are ~500bps lower compared to AT&T & Verizon. A lot of this is due to the business model; T-Mobile leases the fiber used in their network, which means it hits opex rather than capex (Verizon & AT&T own a lot of their own fiber). This leads to lower Ebitda margins but lower capex intensity. T-Mobile also has lower ARPU due to their legacy position as a value provider (~10% lower), but, as mentioned above, they’re showing signs of trying to increase ARPU.
DISH – As part of the merger, T-Mobile divested Boost Mobile to DISH and gave them the option to purchase 13.5MHz of 800MHz spectrum for ~$3.6bln. The hope was DISH would use the subscribers and brand of Boost Mobile, combined with their other spectrum holdings (and 800MHz option), to become a legitimate 4th national wireless carrier. I think this is unlikely to happen due to DISH’s financial situation, but there’s a risk that the spectrum (maybe under a different company) is used to create a 4th national carrier at some point.
6. Valuation Scenario
I’ve put together a 2027 valuation scenario for T-Mobile below (historical financials below):
Revenue
Postpaid revenue
T-Mobile adds an average of ~2mm Postpaid phone customers a year through 2027, meaning ~83.5mm customers in 2027. With ~$53 ARPU (up from ~$49), that’s ~$52.5bln in postpaid phone revenue. Postpaid other (includes FWA, watches, tablets etc.) grows to ~28.5mm connections (from ~21mm in Q2 23), with ARPU increasing from ~$20 to ~$22 (due to increase in FWA mix). This gets us ~$7.5bln in postpaid other revenue and ~$60bln total postpaid.
Prepaid revenue
I’m assuming ARPU is down slightly (~$37) and ~24mm customers, in 2027. This is due to the expected closing of Mint Mobile’s ~2.5mm customers and their low-cost plans. The Metro brand has been doing well relative to the prepaid market (flat while others are losing customers), but the transition to postpaid has been a headwind. This gets us ~$12bln in prepaid revenue.
Wholesale and other service revenue
Wholesale has been working through multiple headwinds over the last few years. Verizon continues to migrate Tracfone brands over to their own network and AT&T is now the primary service provider to DISH and Boost mobile. There are some potential signs of growth, with T-Mobile signing deals with Google Fi and Altice, but Mint Mobile revenues will be switched to the prepaid category when the deal closes (T-Mobile was Mint’s MVNO partner - I’m assuming no regulatory issues from Mint acquisition). This gets us ~$4bln in wholesale revenues in 2027, down from ~$5.5bln in 2022.
Equipment revenue & other revenue
Equipment revenue can be volatile (down >20% YTD through Q3). I’m assuming ~$13.5bln of revenue in 2027 (higher device sales reduce Ebitda due to negative equipment margins). Other revenue I’m expecting to grow low single-digits.
Margins & Capex
Margins
T-Mobile reports operating costs in three buckets: Cost of services, equipment costs, and SG&A. I’ve stripped out merger costs and assumed the following for 2027:
Cost of services – ~18% of service revenue
Cost of equipment – ~125% of equipment sales
SG&A – ~25% of total revenue
This means adj. Ebitda of ~41% in 2027, up from ~34% in 2022 (won’t match T-Mobile’s disclosed adj. numbers as I include certain expenses like stock comp).
Capex
Capex I have averaging ~$11.5bln (management is guiding to ~$10bln in 2023 but I’ve built in a significant cushion) throughout the forecast period (D&A is higher due to amort from acquisition). Forecasted income statement below:
Summary
This scenario would mean ~$37bln in Ebitda and ~$19bln in free cash flow in 2027. I’m assuming ~50mm in share dilution due to the Softbank deal (T-Mobile will issue Softbank ~50mm shares if 45-day VWAP gets above $150 by end of 2025). I’m then assuming ~$55bln in share buybacks from 2024-2027 to retire ~25% of the float (~250mm shares retired at an average price ~$210 per share).
I’m using an 8x multiple to acknowledge wireless carriers will be closer to another capex investment cycle. This scenario results in an EV of ~$300bln with an equity value of ~$230bln ($70bln net debt at ~2x leverage), delivering an IRR of ~18% including dividends. A model only gets you so far though (I’m sure it will prove embarrassingly wrong)! I like to do a model as it helps me get familiar with the numbers and think through all key revenue drivers.
Final Word
There you have it, a look at T-Mobile. I think we see solid returns over the next few years, especially if you believe the following:
Tailwind from rural and enterprise persists, resulting in industry leading growth (even with cable pressure).
Industry focuses on raising ARPU (moderately) after investing >$100bln in 5G spectrum. This should be achievable with with 3 national wireless carriers (down from 4 historically).
Capital is returned through buybacks/dividends and management is able to switch focus from investing in their network buildout, to returning excess capital efficiently to shareholders.
Bonus item: continue to educate the market on their 5G network (not a low quality value provider anymore); T-Mobile does a great job of advertising their 5G network while maintaining their brand identity (provocative un-carrier). Every time I turn the tv on there’s a T-Mobile add waiting for me… (also a great time to advertise due to weak ad market).
I see a good bet. I think the Softbank dilution event might actually be a catalyst for the stock; once the shares are issued, the market can move on from the uncertainty of whether the shares will be issued (~$7.5bln dilution). I recently purchased some shares.